NRF: First quarter showed challenges of bringing inflation under control

Slower-but-continued growth in gross domestic product and other economic indicators during the first quarter showed the difficulty of bringing inflation under control, National Retail Federation Chief Economist Jack Kleinhenz said in the May issue of NRF’s Monthly Economic Review.

“The World Health Organization says the pandemic is over, and the U.S. government has ended its declaration of a public health emergency. But that doesn’t mean the economic challenges brought on by COVID-19 are over,” Kleinhenz said. “For the past year, the Federal Reserve has been trying to bring rampant inflation under control by raising interest rates. The effort has yet to reach its goal, and results from the first quarter show taming inflation without tipping the nation into a recession remains a formidable challenge.”

“A slowdown in GDP is normally seen as a negative, but in the current context is key to controlling inflation,” Kleinhenz said. “Fortunately, the economic data is not consistent with a typical recession.”

Kleinhenz said the U.S. economy “remained in gear” during the first quarter even as GDP growth slowed to a modest 1.1% annual rate from the average 3% in the previous two quarters. The number could have been more than two percentage points higher, but many businesses reduced built-up inventories rather than producing or buying more goods. Consumer spending, which accounts for two-thirds of GDP, grew 6.5%, up from 0.1% growth the previous quarter as disposable personal income saw annual growth of 8.4%.

The Employment Cost Index showed growth in private manufacturing wages and salaries dropped to 4.9% in the first quarter from 5.1% the quarter before but remained above the 3.5% rate needed to be consistent with the Fed’s 2% inflation target. Heading into the second quarter, employment numbers were better than expected despite high-interest rates, with a net jobs gain of 253,000, a year-over-year wage increase of 4.4%, and the unemployment rate of 3.4% tying January for the lowest in more than 50 years.

Inflation as tracked by the Personal Consumption Expenditures Price Index – the Fed’s preferred measure – was 4.9% year over year in the first quarter. That was down from 5.7% in the fourth quarter and far below the 6.4% seen a year earlier. The core PCE index, which excludes volatile food and energy prices, was at 4.7%.

Amid those numbers, the Fed last week raised interest rates another quarter-point to an upper bound of 5.25%. Chairman Jerome Powell said sentiment on the Fed’s Federal Open Market Committee favors a pause in interest rate hikes, but that the panel is not yet ready to commit. Kleinhenz said the key questions are how the Fed will know when to stop raising rates and how soon after that it will start to lower them.

In announcing the increase, the Fed said tighter credit conditions are likely to “weigh on” economic activity.

“That is consistent with our views on the risks to the 2023 economic outlook,” Kleinhenz said. “But in the bad-news-is-good-news world of trying to control inflation, that may be exactly the result that is needed. The key is finding a way to control or manage the uncertainty.”